ETF Edge

Nontransparent ETFs are gaining traction and could mean big money for industry

Nontransparent ETFs gaining traction and could mean big money for industry
Nontransparent ETFs gain traction. Why they could mean big money for the space

It's becoming clear that nontransparent exchange-traded funds could mean big money for ETFs.

So say industry pros Chris Hempstead, director of institutional business development at IndexIQ, and Douglas Yones, head of exchange-traded products at the New York Stock Exchange, following the SEC's approval of the partly confidential fund structure in June.

Now, Fidelity, T. Rowe Price, Natixis and Blue Tractor have all gained preliminary SEC approval to launch their own nontransparent ETFs.

Unlike standard ETFs, which are required to disclose their holdings daily, nontransparent ETFs will only be required to disclose their holdings once a quarter, giving active managers — who prefer to keep their investing methods under wraps to avoid getting front-run — another vehicle through which to employ their strategies.

That's likely to attract even more assets to the ETF space, adding to the over $4 trillion currently under management, Hempstead said Monday on CNBC's "ETF Edge."

"I think there's going to be a place for" these kinds of funds in the ETF market, Hempstead said. "It's going to come down to the $8 trillion mutual fund industry who hasn't really put these strategies into an ETF wrapper. How do they sell it? How do they distribute it? Who are they marketing to? The market will absorb it. The market makers and liquidity providers ... will be able to support these products."

And while running an ETF versus a mutual fund won't be the key to improving an active manager's performance, the lower costs associated with ETFs could give them a slight leg up, said Yones, whose firm is working with all of the approved nontransparent-ETF issuers.

"A wrapper's not going to change performance. It can change tax efficiency. It can also change cost," he said. "It's important to remember: a lot of times, active management, because it's in an expensive wrapper, [is] charging 50 or 60 basis points."

That cost tends to weigh on performance, which gets "eaten up by the cost of the wrapper," Yones said. "We can take that away. We can put it in a more tax-efficient vehicle. Now, all of a sudden, an active manager has a better shot at beating their index."

It's also a win for retail investors, who may eventually be able to buy into their favorite active managers' strategies in a cheaper way, possibly even 50-75 basis points lower than in the mutual fund sphere, Yones said.

"In the active world, there are star managers. There are a lot of active shops that have done it right for year after year. They've beaten their index. They've done a great job. Why not offer the structure to them?" he said. "I think that there are certain managers that people would love to see in an ETF wrapper."

If they're good enough, they may not even have to sacrifice their higher fees, Hempstead said.

"Just because a few large managers have been able to cut fees to nearly zero, does not mean that a successful active manager, one that you're familiar with where you're going to put your money in, can't charge 30 or 40 or 50 basis points to manage that fund," he said. "If they're earning the alpha and they're earning the business, then they should charge more."